Category: The Month That Was

Wow. That’s about the only way to summarise the events of March 2020. It will be remembered as the most volatile month in sharemarket history. Here are some simple numbers: Marsh saw 12 of the largest 20 points falls in the Dow Jones, the largest single day fall in history (-12%) and the largest intraday point swing of 1,904 points on Friday the 13th. In fact, the Dow experienced both a bear market, again the fastest in history falling 20% in just 22 days, and a bull market, increasing 21% in just three days. Closer to home, the ASX experienced its biggest one day fall since 1987, off 9.5%, the fastest 30% fall and an intra-day swing of 14%. Honestly, even working through the GFC we had never seen this before, waking up and heading into work was an unnatural feeling as COVID-19’s impact expanding globally.

It’s clear that the virus was under-appreciated until the market peak on 20 February and now we must question whether it has truly been priced into markets given the volatility experienced and likely set to stay with us for some time. How long will shutdowns apply? How long will quarantining be in place? How long will social distancing measures be required? These are all important questions both as humans exposed to this virus but also as investors attempting to negotiate our way through a true unknown, unknown, as Donald Rumsfeld would have put it.

March saw some incredible things occur as markets reacted to the threat of a global recession, or at least recession across the major developed and developing economies who appeared woefully underprepared. There was the 2-day breakdown in bond markets that occurred in the middle March, during which the yield on US Government Bond’s spiked as much as 30% in a single day, more volatile than equity markets. One of the more interesting flow on effects, was Vanguard’s announcement that they had increased the buy-sell spread on their bond funds from 0.15% to 1.79%, that’s almost a 2% fee to redeem your investment! Not what you would expect from a low cost manager.

Leading on from this, which is highlighted more later, March saw the return of the active manager with most tending to outperform amid precipitous falls in global sharemarkets. It was clear amid the ‘carnage, that a number of issues were exacerbating the sell down, low volatility index strategies, algorithmic trading, huge selling from pension funds and simply investors taking on too much risk for too long. When times are good, like the last 10 years, active managers will naturally underperform their benchmark, but it is when times get tough that they tend to pay off protecting your capital when most needed. There is an old saying about ‘getting what you pay for’ Our view is that a dollar saved is more valuable than a dollar gained.

After somehow avoiding the worst of the Royal Commission spotlight, the industry super fund sector has seen a blowtorch applied to their business model. The issues were twofold in March, the first being the huge number of members seeking to switch investment options as market volatility increase. The issue? Most of these funds hold allocations of up to 30% in unlisted, illiquid assets that are rarely revalued, meaning the only way to fund investment switches was by selling down their most liquid assets; equities. The second, was the announcement of the loosening of the $10,000 early access to superannuation rules, which placed further pressure on these illiquid structures. In some cases, these funds hold as little as 2% cash in their ‘balanced options’. The result? An overnight revaluation of said unlisted assets by 7.5%; that’s right overnight. The concern was so high that the chief lobbying group for the sector ask the RBA for a loan to bailout the impacted funds. Some of our views were published in the IFA during the month. All said and done, Australian Super fell over 11% for the quarter, and 15% from the high. We haven’t read about any pay cuts or job losses in this sector yet.

Bond and credit markets were one of the lowlights and highlights of the period. With many industry funds relying on unlisted private credit to boost returns, it became clear the risks were higher than many appreciated. Investors in high yield or junk bonds saw losses in the realm of 20-30% in just a few days; in our view these securities now offer some value. We began to see some normalisation after the coordinated central bank policies around the world (more below) with 50 companies issuing over US$100bn in primarily BBB-rated bonds in March; another record.

As we enter what many are suggesting is the initial peak in Australian and US virus infections, the focus is increasingly moving to how we recover from this. As usual, media and economic commentators are putting forward excessive statements, with as much as 11% unemployment and full-blown depression; our view is that this simple isn’t palatable for any Western Government and we are more likely to see a relaxation of shutdown measures combined with greater public testing. The initial impacts are clear, with a recover 3.3m new jobless claims in the US in the last week of March, swamping the previous 695k weekly record.

On the positive side, it has become very clear that central banks and Governments around the world have been far more prepared for the economic impacts of this crisis than the GFC. March saw coordinated stimulus efforts ranging from US and Australian interest rate cuts to 0.25%, liquidity back-stops for the major banks in the form of low cost funding and Quantitative Easing measures implemented in Australia for the first time. The RBA and Federal Reserve will both be buying Government Bonds directly from financial institutions, along with residential mortgage-backed securities; in the case of the US, this spread into buying bonds directly from US companies. This is based solely on ensuring banks have enough capital to keep lending to business and people in need. Combined these with fiscal policy of c10% of annual GDP in the US and Australia and this is likely enough to offset at least a few months of ‘hibernation’. It’s obvious that the Australian Government understands that spending $200bn to keep people employed is better than spending 10 years trying to get them re-employed.

Market volatility tends to see markets clean out very quickly, with many of the excesses associated with a 10-year bull run quickly disappearing. We were therefore interested to see the announcements from Mayfair Platinum which sells itself as an alternative to term deposits, and which is marketed by the Switzer Group. In the same week, we received a marketing email about investing in to Cannabis, from the same group, amid the most volatile period in market history; as the millennials say WTF?

Looking forward, reports suggest some 98% of major industrial companies in China have resumed operations in March, with nearly 90% of their workers back on the job. The Wall Street Journal also reported that the US is likely to see a peak in infections in the coming week; we can only hope.

Just when we thought the global economy couldn’t get any more unpredictable, January brought the outbreak of the Coronavirus in China, a US-Iran tit-for-tat engagement, the worst Australian bushfires in recent history and the UK formally leaving the European Union. Yet as usual sharemarkets weren’t overly worried, with the ASX adding 5% (the best start to a year in a decade), and the US falling by less than 1%. This time, it was a stronger than expected US economy, which grew 3% in 2019, supporting higher valuations.

The outbreak of the Coronavirus, which by all reports has now killed over 300 people, couldn’t come at a worse time for the Australian economy. The resulting shutdown of inbound flights from China is likely to have a substantial impact on tourism and when combined with the bushfires will have a negative impact on consumer spending. This comes after a retail spending rebound of 0.9% in November but subsequent slump in December as the Black Friday sales brought spending forward.

The ASX All Ordinaries finally hit 7,000 points in January, this comes some 12 years after it was originally predicted by a number of ‘experts’ to occur in 2008. The key drivers behind the performance were the ever-growing CSL and BHP Group. Interestingly, Australian economic data remains strong, with unemployment falling to 5.1% and inflation holding at 1.8% even as the consensus turns negative towards growth. The S&P 500 and a number of key Asian indices also hit all-time highs during January, before giving back some gains as the month came to an end.

It’s been a busy few months for the profit- for-member of industry super funds, after the APRA Heatmap release in December which embarrassed a number of groups, economist Warren Hogan suggested the largest funds should be forced to hold additional capital not unlike a bank. He suggests the increasing allocations to illiquid assets and market power of the largest funds may represent a systemic risk and should be regulated accordingly. At present, management relies on incoming contributions to ensure

In a sign of the times, the huge venture capital fund run by Softbank, was identified as funding all three of the largest ride sharing competitors in Latin America, Didi, Uber and Rappi, as they attempt to destroy each other and win the important Such is the size of the fund that they can bet on all three players and still expect to make a profit.

The Chinese economy benefitted from the actual signing of the Phase 1 Trade Deal with the US, however, many are questioning whether China can actually facilitate the purchase of an additional $200bn in US exports by 2021 as agreed. It is likely to have a negative impact on China’s other trading partners, including Australia and the US, as commodities like LNG and motor vehicles are sourced from the US. Chinese growth hit 6.1% for 2019 but many now expect it to fall below the 6% mark for the first time. Positively, industrial production is improving once again, up 5.7%, and retail sales continuing to boom, up 8%. The result was an improvement in the IMF’s global growth forecast, from 2.9% to 3.3% and Japan’s as well, from 0.5% to 0.7%.

It was the well-known technology stocks that lead the market higher as the decade turned into 2020, with Facebook, Apple and Google all hitting all-time highs during the month. Many are suggesting these valuations are reasonable given robust fundamentals and exceptional growth levels like Facebook’s 24% year on year revenue growth and 56% earnings margin. Amazon initially under performed but reached another high after hours following a 50% beat on its earnings per share estimate for the final quarter.

President Trump appears to have beaten the self-titled impeachment ‘witch-hunt’ with the Democrat’s unable to swing enough Senators to include additional witnesses in their high profile trial. The consensus appeared to be that there was little value in proceeding with the impeachment for the party given the President has just 10 months before another election.

After a multi-year boom in the share prices of the few Australian lithium miners, the sector has been hit with a reality check in recent months. Galaxy Resources (GXY) announced that production at their Mt Cattlin mine would be put on hold for the foreseeable future, blaming an oversupply and subsequent 50% drop in lithium prices for the closure. They joined the likes of Pilbara Minerals and Mineral Resources to reduce production.

In a year when almost every asset class delivered strong returns, the renowned Ray Dalio and his Bridgewater Associations Pure Alpha Fund suffered its first annual loss, dropping 0.5% in the year, piling more pressure on the hedge fund sector as investors find more reasons to move towards passive strategies. Another hedge fund manager, AQR Capital, stressed that future returns remain lower than ever, indicating their internal models predict annualised returns of just 4% from a traditional 60/40 balanced portfolio.

Engineering and construction specialist CIMIC Group, previously Leighton’s, unexpectedly reported a $1.8bn writedown due to unpaid debts in Dubai, exacerbated by delays and additional costs on the West Gate Tunnel project. They weren’t alone in confession season, with agricultural supplies outfit, Nufarm, forecasting a weaker second half, along with e-commerce retailer Kogan, and Treasury Wine Estates, which was once again hit by an oversupply of cheap wine in the key US

Whilst it was an interesting month in investment markets, our thoughts and wishes must go to those impacted by the bushfires sweeping Australia. The scale of these fires is unprecedented and this has been brought closer to home with smoke covering Melbourne’s CBD in recent weeks. In an effort to provide any help possible, we have allocated our annual Client Christmas Gift budget to a number of worthy causes related to the bushfires.

Moving to investment markets, 2019 was one of the strongest years for investment returns since the GFC and the best in a decade. The ASX 200 increased over 18% in price terms, the US S&P 500, 28%, and the Nikkei 225, 18%. This came amid what seemed to be one of the most uncertain, negative and strained economic and social background in recent memory. The key reason behind the strength? A continuation of the trend since the GFC, low interest rates, quantitative easing and money printing, forcing investors into riskier assets for any hope of returns.

In terms of companies and sectors, it was Healthcare (43%), Information Technology (33%) and Consumer Discretionary (32%) that lead the way in Australia with two of the best performing companies, Fortescue Metals and Magellan Financial (+150% respectively). Global returns were also exceptional, with S&P 500 members, Apple (89%), NVIDIA (77%) and Mastercard (60%) among the top 50

December saw the UK’s Conservative Party take a resounding victory, re-electing Boris Johnson and his ‘Get Brexit Done’ mission and pushing back against the more extreme policies adopted by the Labour Party under Jeremy Corbyn. This effectively guarantees that Brexit will proceed, with the process of negotiating bilateral trade deals with countries including the US and Australia in full swing. The result was received positively by markets, as everything seems to be these days, removing another potential source of uncertainty and improving the hope of a global economy recovery.

In another positive sign for the global economy and sharemarkets (not to mention Trump’s re-election chances), the US and China have come to an agreement regarding a number of issues behind their trade war. The so-called ‘Phase One’ deal is expected to double US exports to China, initially from the struggling agricultural sector, and includes better intellectual property protections, curbing of technology transfer to Chinese firms and the expectation that China will further liberalize it’s financial markets. More recently, China’s central Government also released a further $115bn into the economy by once again reducing the capital ratio required of their banks.

APRA released its long-awaited super fund ‘Heat Map’ in December, attracting the ire of the strongest and weakest performers alike. On first view, it provides a useful reference tool particularly for those in super funds forced onto them by their employers. Looking more closely, however, some dangerous precedents have been set that are based around the near sole focus on historical performance and reported fees, with limited consideration given to transparency or flexibility. The worst performing included Maritime Super, BT Super for Life, and Energy Industry Super, with a number of corporate plans the worst in terms of fees, Pitcher’s, Goldman Sachs and Qantas. It was a busy month for the industry fund sector, with ASIC releasing a report on the quality of financial advice they provide, which concluded that 51% of funds provided non-compliant personal advice to members.

The Australian economy continues to struggle, with annual economic growth of just 1.7% and a quarterly increase of 0.4%. The performance was once again driven by the consumer, who is spending little on retail but more on services, dining and experiences, whilst falling Government spending was the reason behind the slowdown compared to the third quarter. Australia’s reliance on big business, including traditional banks and retailers, and our lack of innovation is becoming increasing obvious in our economic results. Interestingly, Australian tax on company income is the highest in the world as a portion of GDP. Australia is in desperate need of personal and corporate tax reform. In the US, unemployment fell to 3.5% during the quarter, the lowest level since 1969, with expectations this will have a flow on impact on wage inflation in 2020.

The Wattle Partner’s Investment Committee have for some time been undertaking due diligence on a climate change and ESG, or Environment, Social, Governance driven portfolio, which will be launched in 2020. Given our research, we were interested to hear Kenneth Hayne’s, famous for running the Financial Services Royal Commission, comments on the issue and where board and management focus should truly be.

We were intrigued to see GPIF, the Government Pension Investment Fund of Japan with over $1 trillion in assets under management, announce they would no longer be lending stock to short sellers. Lending stock is commonly used by industry funds, index funds and most large managers in order to add an additional level of return associated with the lending fee. GPIF indicated this was worth as much as $573m to them. This comes after a tumultuous year for many Australian companies from Blue Sky to Rural Funds and Wisetech Global.

“I’m no Skase” read the headline in the Australian Financial Review. The interviewee was the head of IPO Wealth and Mayfair Platinum, two investment opportunities that are being heavily (and expensively) marketed for their income offerings to yield starved Australian investors. The group’s approach appears to involve guaranteeing income returns to investors, on lending their capital to listed and unlisted companies, and hoping they perform sufficiently to be able to repay investor’s capital. In late 2019 they ran an extravagant launch after acquiring the derelict Dunk Island for $135m, of what we assumed is investors capital. If there is a sign of the market nearing high, this may be it.

Amid high levels of uncertainty, sharemarkets around the world continued to deliver strong returns for patient investors, evidencing the importance of compounded and remaining invested throughout the cycle. The S&P 500 hit another all-time high in November, reaching 3,153 points as sentiment around the world began to improve. Closer to home monthly returns were strong at around 2.7% for the ASX 200 taking the 12 month return to over 20%. This strong performance has occurred at a time of great uncertainty around the world, but with companies in generally solid health.

The ASX has outperformed most markets over the last 12 months after trailing for many years, driven primarily by a recovery in the consumer staples (8.25% for November), healthcare (8.87%) and communications sectors (7.51%). Yet this strength is coming during a difficult period for the Australian economy with the unemployment rate ticking up to 5.3%, growth stuttering at 1.4% and the RBA threatening to enter the Quantitative Easing race to the bottom. Investors are naturally wary, evidenced throughout our recent trips around Australia to meet with clients and potential clients. However, with potential positive outcomes for both Brexit and the US-China Trade War on the cards in December markets may have another leg up before Christmas.

The outlook for the Australian economy remains mixed, on one hand private sector wage growth weakened to 2.2% for the year, whilst retail sales showed signs of improvement returning to positive territory in August and September; retailers remain hopeful Black Friday sales will stimulate pre-Christmas spending. Public sector wage growth continues to improve faster than the public sector at 2.5%. Tween fashion retailer Bardot was the latest to enter administration as sales weakened and retail rents put pressure on management with more job losses.

The union-fund sector experienced a busy month with several major acquisitions and the announced merger of MTAA and Tas Plan Super to create a $23bn fund. Industry Funds Management, the investment management are owned by the major funds announced the purchase of a US oil pipeline for c$15bn; an interesting decision in the light of the sectors push towards more sustainable and environmentally conscious investing. Unisuper and Macquarie Bank teamed up to bid for illion, in what experts are describing as a new type of infrastructure asset. The company is a data registry, not unlike Link Administration Services.

Australian financial services regulators continue to push forward with a more aggressive approach. Following the introduction of the Banking Executive Accountability Regime, which includes supervision of executive pay, APRA released a paper addressing the potential for its team to attend and ‘observe’ company board meetings. The introduction of the financial services ethics legislation, FASEA, continues to confuse both the regulators and professional bodies.

As highlighted in our previous issue, the flow of junk bond listed investment companies continued in November, with private equity firm KKR raising $925m for their Credit Income Fund, which invests in unrated high yield debt and illiquid debt like leveraged loans and targets an income of 4.-6% per year. This followed a similar issue by Partners Group, of $550m. Credit has been a happy stomping ground for family offices, pension funds and other sophisticated investors, but questions remain over its appropriateness as a fixed income alternative.

One of the biggest stories of the month was Westpac’s seeming capitulation to the anti-money laundering authority AUSTRAC. On the face of it, and as captured by both political parties, Westpac appeared negligent in not identifying or reporting an extraordinary number of questionable transactions. Yet as Chris Joye from Coolabah Capital and Paul Bassat explained, the issue may be more nuanced than that and fall back on the legacy technology systems of our major banks. Their inability to implement sweeping changes due to the intricacies of systems built decades ago means technology issues like those experienced by Westpac and CBA will not go away anytime soon.

The $3,500 per ticket Sohn Hearts & Minds Conference was run and done during November, with the top picks from Australia top managers discussed later in this report. The charitable institution was able to put together an enviable selection of thought leaders including Ray Dalio of Bridgewater Associates and Howard Marks of Oaktree Capital, two experts we respect highly. Two interesting takeaways were Dalio’s apparent recommendation that gold bullion would become an increasingly important hedge in a period of political instability and lower liquidity in markets. Marks on the other hand touched the concept of Modern Monetary Theory that is receiving support in the US. He struggled to understand how it does not lead to inflation and volatility noting: “it doesn’t seem to me that you can really run deficits of any size for any period of time … without having some effect on the desirability of your currency,” the fund manager remarked. “To me, that doesn’t make sense.”

In what we at Wattle Partners are taking as a sign that the oil market may be hitting its peak, Saudi Aramco, the oil producing nations key oil production business, looks to have successfully gotten its float away. The nation is floating 1.5% of the business valuing the shares at US$25bn and the company as a whole at around $1.6 trillion. It is one of the most profitable companies in the world and is expected to pay out dividends of $75bn in 2020 yet it comes at a time when OPEC’s forecasts for demand growth in the decades ahead continue to slow.

There were suggestions that liquidity issues may be building up in both industry pension funds and unlisted property trusts when Lend Lease put the Westfield Marion Mall in SA up for sale. The property was sold at a discount to Westfield’s Scentre Group’s valuation by around 9% and above the 5.13% discount or capitalisation rate applied by the managers, selling at 5.6% suggesting values may be falling in the face of substantial retail pressure. That said, it was the largest retail sale of the year.

The market continues to climb amid increasing uncertainty and a seemingly never-ending flow of bad news on the geopolitical front. In fact, the S&P 500 once again hit an all-time high during October. Yet if you speak with any investor, professional or individual, there is a feeling that things have never been worse. Whether it is the proliferation of social media and the availability of information, or just the end of a bull market, it’s always prudent to ask, what if you are wrong? In this vein, we were interested to read the thoughts of Montaka during the month:“We believe investors are underestimating the potential for more optimistic scenarios. Consider how equities would perform in an environment of easy monetary settings, a stabilised global economy, an acceptable Brexit deal and relief from US trade measures while President Trump seeks re-election. Such a scenario, while far from certainty, is far less improbable than most currently believe, in our view. The point is that investors need to remain invested”.

Sharemarkets around the world were generally mixed, with the US performing well on the back of continued strength in the consumer sector. The Japanese market benefitted from a weaker currency, sending the index up over 5%, whilst the ASX essentially treaded water, falling -0.4% in price terms. The major detractor was the banking sector (-2.8%), as the impacts of the financial advice scandal and more aggressive regulation continue to impact profits. On the positive side, the healthcare sector (+7.8%) benefitted from earnings upgrades from RMD and a reiteration of 7-10% growth by CSL.

Some of the biggest news in what was a very active month, was the announcement that Chinese GDP growth had fallen to 6%; the slowest rate in 27 years. Growth across the board appears to be slowing, with investment in the agriculture, manufacturing and industrial sectors slowing but infrastructure spending ramping up as the Communist Party’s 70th anniversary nears. The rate is well below the 6.6% of 2018, but the economy remains healthy was retail sales climbing 7.8% in September and industrial output up 5.8%. As highlighted, the Australian economy is increasingly reliant on strong Chinese growth, so signs the US-China Trade War may be coming to an end should be seen as a positive.

There were increasing signs that the technology driven market bubble may be coming to an end. With a short report targeting logistics software specialist Wisetech Global seeing billions of market capitalisation lost. The We Work debacle was highlighted in all of its glory with renowned venture capital investor Soft Bank global recapitalizing the company after it’s failed IPO. The capital injection, which saw the failed CEO walk away with over $1bn, valued the company at just $8bn, just a few weeks after the company attempted to sell shares in its IPO at a value of $47bn.

Inflation remains non-existent in the US, at just 1.7%, with costs kept under control from sustained low interest rates and a lack of wage pressure due to more flexible employment. Unemployment continued its march lower, hitting just 5% during the month, with the participation rate still strong at 63.2%. The results were similar in Australia, with unemployment falling to 5.2% in September, what’s even more impressive is the participation rate reaching multi-decade highs of 66.1%. That being said, the rationalization occurring in the major banks and traditional business sectors will likely see increasing redundancies in the years to come.

It was another eventful month in geopolitics with the announcement that the US and China would re-engage in talks to end their trade war. The announcement suggested the Chinese would begin buying $50bn in US farm products and allow financial services companies more access to their market, in return tariffs scheduled for 15 October were put on hold. This came at an opportune time as US factory activity had contracted for the second straight month in September, hitting a 10 year low and increasing concerns about the economy. Once again, the ‘Trump Collar’ was in force, with the President supporting weaker stock markets through good news. On the other side of the Atlantic, PM Boris Johnson managed to negotiate a new deal with the EU and seems closer than anyone could have predicted to deliver Brexit in an orderly manner. His Halloween target has been pushed back by Parliament, yet this is a positive sign for Brexiteer’s and anyone seeking some certainty. The UK is now set for a pre-Christmas election as Johnson seeks another mandate from the people. It’s worth keeping in mind the UK economy represents just 3% of the world.

The Federal Government made the questionable decision to announce an inquiry into why the major, and junior, banks didn’t pass on the recent RBA rate cuts in full. The ACCC has been asked to examine the reasons behind this, yet to most market participants it is incredibly clear. The banking sector is seeing costs increase from every angle, including staffing, funding via overseas markets and the costs of increasingly complex regulation. This is all having an impact on their net interest margins (NIMs) which represent the difference between their cost of capital and the interest rate they charge. Sustained low interest rates are dangerous for pension funds and banks alike, as the low returns on offer push them towards insolvency, or the ability to profitably fund their own operations. By holding onto a small portion of these rate cuts, the banks are attempting to protect their capital position and profitability.

The likelihood of further short-term rate cuts has effectively disappeared, with inflation printing at 1.7% for the 12 months to September. Whilst still below the 2-3% RBA target, it is substantially higher than most developed economies around the world. Looking to the US, economic activity improved to an annualised rate of 1.9% in the third quarter, below the 2% of June, but still one of the fastest in the G7. The better than anticipated result was due to the resilient consumer, which is benefitted from wage growth and full employment, as consumption increased 2.9%. Businesses continue to hold off on investment in the face of the trade war, which declined 1.5%, far better than the 6.3% in the previous quarter.

Is this the end? As mentioned previously the long awaited listing of shared office provider We Work was pulled and saw its valuation fall nearly 80% overnight. The share prices of Uber and Grubhub fell heavily as investors tired of lofty valuations and hoping for growth. Closer to home, Wisetech Global was called out by short sellers from Asia, the Latitude Finance IPO was pulled for a second time, as was Property Guru. In Tasmania, the Hobart Airport was sold to a syndicate lead by Queensland Investment Corporation (QIC) at a multiple of 26 times earnings. This compares to the ASX which trades closer to 13 times. There is an increasingly feeling that a lack of growth and easy access to capital is seeing valuations move out of control potentially capping long term returns at lower levels.

It was another strong month for the ASX, with the larger company focused ASX200 adding 1.3% in price terms for September and the Small Ordinaries an impressive 2.0%. Once again, the importance of mining and banking to the Australian economy was highlighted, with financials adding 4.1%, as both ASIC and APRA’s litigation against the sector was thrown out. As the calls for climate action increase, the economy continues to benefit, with the energy sector up 4.7% and materials adding 3.1% buoyed by gold and iron ore production. The defensive healthcare (-2.5%) and property trust sectors (-2.7%) were hardest hit. The S&P 500 delivered a solid return as another round of earnings season is set to begin, with the benchmark index up 1.7%. The positive return came amid increasing concern about the trade war, however, consumer numbers remain strong and markets were buoyed by the continued support of the Federal Reserve. The result took the year to date return to 19%, the best since 1997.

Central banks around the world responded to weakening global growth in September. The ECB moved their cash rate further into negative territory to -0.5%. Despite the protestation of the White House they also recommenced their QE policy, buying $20bn of assets per month in an attempt to stimulate the banking sector to lend again. The US Fed finally capitulated to pressure from President Trump, cutting rates by a further 0.25%. They were also forced to step into the overnight lending market, to the tune of $128bn, as inter-bank lending froze and interest rates spiked in a rehash of 2007. In Asia, the PBOC responded by cutting the bank reserve ratio by banks by 0.5%.

The increasingly combative Australian regulator’s took another hit, with APRA losing its case against IOOF. The judge indicating that APRA’s case was systemically weak and failed to prove that the reimbursement of customers from the super funds ‘reserves’ was inappropriate. This followed ASIC’s case against Westpac in relation to responsible lending laws being thrown out in August. September also saw the ATO ramp up pressure on SMSF trustees. They sent letters to 18,000 trustees holding more than 90% of their fund in a single assets (read direct property) with threats of fines and disqualification.

In a predictable and after the fact announcement, the OECD downgraded the outlook for the growth in the Australian economy to 1.7%. This coming just a few weeks after the weak June quarter result of just 1.4%. The OECD called for more taxation reform, including an increase in the GST and company tax cuts in an effort to stimulate investment. They noted the impact that trade uncertainty is having on investment decisions. Global growth in 2020 was reduced to 3.0% and 2.9% in 2019 as the US-China trade war, high savings rates and low business investment continue to bite. Whilst growth is slower than trend most economies remain in reasonable shape, with inflation in the US and Australia at 1.7% and 1.6%, and unemployment of just 3.7% and 5.3% respectively.

Australia achieved its first current account surplus in 44 years, bouncing back from a deficit of $2.9bn in July to $5.8bn in August as commodity prices remained well supported. This comes at a time when growth in the Chinese economy, which is our most important trading partner (chart below) continued to slow. Industrial output growth was 4.4% down from 4.8%, and exports fell 4.3% driven by a 16% reduction in exports to the US.

If the attacks in the Strait of Hormuz weren’t enough, Iran has reportedly increased geopolitical risk in the Middle East by facilitating an attack on Saudi Arabia’s key oil projects. Interestingly, this comes at a time when the Saudi’s were planning the IPO of this massive state owned business. The immediate reaction has been a spike in oil prices around the world, yet reports suggest at least half of production has already been reinstated. As history has shown, the cure for higher oil prices is higher oil prices as this would present a huge drag on an already weakening global economy

In a sign that the incredible flow of capital into private markets may be hitting its ceiling, the IPO of We Work was put on hold during the month. Some are suggesting public markets simply weren’t willing to pay the lofty valuation of a company that lost (yes, lost) USD$1.4bn in the first 6 months of 2019 alone. More importantly, they suggest that this may be a turning point after years of capital flooding into private equity, venture capital and other unlisted assets has increased competition in the sector. We aren’t sure how $1.4bn of money can be lost in 6 months, but here is an explanation of how We Work ‘makes’ money. Interestingly, public markets valued the company at just $15bn only a few months after the company raised venture capital on a valuation of $47bn!

There is growing pressure for industry funds and advisers alike to reduce expectations for investors after several years of stronger than targeted returns. The typical balanced fund targets a return of CPI + 4.0% with the average of around 7-8% over the last 12 months. But as it stands and as highlighted by the likes of Schroders, such targets are getting more difficult to achieve. The traditional Government bond allocations which should make up 40-50% of portfolios are now offering negative returns and sharemarkets remained challenged. Recent returns have been delivered by taking more risk but the likes of ex Lazard CEO Rob Prugue are concerned about the focus on return ‘scorecards’ rather than security of members retirement funds.

In one of the more enlightening fund manager presentations we have attended, David Harding of Winton fame, visited Melbourne to discuss the difficult conditions for his trend following fund. After delivering during the GFC the fund has been a stalwart in Australian portfolios but returns since have been positive but weak. Harding discussed the problem of crowding in his trend following approach, which reduces the potential returns on each investment decision stated his ‘hope’ for 2020 was higher returns. He also discussed the difficulty many scientists and engineers have in investment markets, believing it is a science and not a combination of both art and science.

The Australian reporting season was disappointing but given the context of slowing domestic and global growth and increasing geopolitical risks a positive result was about the best investors could expect. AMP Capital summarised it neatly with their research indicating only 36% of results were above expectations, well below the average of 44% and only 58% of companies have seen their earnings rise (compared to 77%) in FY19. The result was that earnings growth for the market was just 1.5%, below expectations of 2.0%, and some 28% of companies cut their dividends as a result. Once again it was the resources/mining sector that drove the market earnings improvement (up 13%) with the rest of the market combined falling 2%, particularly financials which are struggling amid a property slowdown and remediation cost blowouts.

Markets around the world struggled as the US-China trade war took another turn, with US markets falling around 2% and bond yields collapsing once again. The All Ordinaries and ASX 200 both fell around 3%, struggling through reporting season as the key mining and energy companies saw falling commodity prices. The Asian markets were hardest hit with the Hang Seng off 8% in August suggesting the Chinese economy is taking the brunt of the trade war. The traditional hedges once again came to the fore with highly rated Government (including negatively yielding German bonds moving further into negative territory) debt adding positive returns and gold rallying another 10%.

Strong performing property trust, Rural Funds Group, came under pressure following a short selling attack by Bonitas Research which was founded by a member of Glaucus responsible for the pressure on Blue Sky and Quintis among others in recent years. The group accused management of fraudulent activities, undisclosed payments and inflated rental figures which were flatly denied. The share price immediately fell 40% but has since recovered to make up the majority of the loss ground. We are always interested to understand where these groups obtain the shares to then short-sell on the market, interestingly Vanguard is the largest and most passive shareholder at 9%.

The outlook for Australian economic growth continued to weaken during the month after building approvals fell a further 9.7% in July. Economists had been predicting a flat result. It was the apartment developments driving the fall, which were down an incredible 18% taking the 12 month fall to 28.5%. This came shortly after weaker than expected business investment data was released showing a contraction of 0.5% in the quarter. Once again, economists were expecting growth of 0.4% suggesting they are disconnected from what is happening in the real world. The result has been a reduction in Q4 GDP growth expectations from 0.5% to just 0.3%, and we wouldn’t be surprised if it’s even weaker than that.

In a sign of the increasing power being wielded by the union fund sector, IFM Investors, who own Australia’s largest energy network, Ausgrid, announced an ambitious policy to begin cutting carbon emissions by up to 100%. The Coalition Government responded by suggesting the asset owners should not be passing these costs onto consumers, who are also members of many of their super funds.

The Australian economy delivered a second successive record trade surplus seling $8bn more than we exported in June, some $1.8bn higher than in May. The country is now poised for our first current account surplus since 1975! The primary drivers were continued growth in iron ore and coal prices and weaker imports of motor vehicles and aircraft.

The Trump Administration’s tot-for-tat with China continued unabated, but as usual showed signs of improvement whenever the S&P 500 began to fall. President Trump declared the Chinese ‘currency manipulators’ following the devaluation of the Yuan, and continues to call on the Federal Reserve to support his ‘negotiation’ via even lower interest rates. Throughout the month the rhetoric fluctuated between an interest in restarting negotiations, to a further escalation of tariff introductions. As we write, a further $300bn in imports are expected to be hit by 15% tariffs on the 1st of September unless the White House puts these on hold once again.

ASIC’s case against Westpac, but effectively the entire banking sector, was thrown out of court during the month. ASIC had been pursuing Westpac under the new Responsible Lending legislation, questioning whether Westpac’s use of spending benchmarks was sufficient to justify higher loan limits being offered. The judge now famously said ‘I may eat wagyu beef everyday washed down with the finest shiraz, but if I really want my new home, I can make do on much more modest fare’. This is one of few too many realistic court results which suggests individuals can take personal responsibility over their spending and adjust their expenses after taking out a loan. It may be a turning point for the sector that have been pushing away prospective borrowers for several months now.

The NBN reduced their forecast sign-ups for 2020 from 7.5m to 7.0m as the pressure of improving 4G and 5G networks continues to grow. The announcement is likely to be a positive for Telstra with most NBN sign ups effectively being a lost customer of the group. Management are expected to update guidance accordingly.

Growth in Chinese industrial output fell to a 17 year low in July in a sign that the trade war and US tariffs are hitting the economy harder than expected. This is not good news for Australia. The broad Industrial Output measure was up just 4.8% for the month, well below forecasts of 5.8%. Retail sales on the other hand were more positive, increasing 7.6% but below the 8.6% expected by economists. Exports remain under pressure to both the US and Europe. On the flipside, US retail sales remained highly resilient increasing for the fifth straight month by 0.7%. It has been the lower cost, middle income focused chains like Walmart benefitting and the luxury department stores being hardest hit.

You will shortly be receiving our latest Unconventional Wisdom Journal, which among other topics covers the incredible search for yield that is occurring around the world and the many areas where investors appear to be taking more risk than they should. One such article focused on a listed investment trust that raised $1bn from retail investor and incredibly holds over 10% of the portfolio in CCC rated junk bonds. These carry the same rating as just defaulted Argentinian bonds. Go figure.

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